Tuesday, October 16, 2007

It's a sign of the times that when the biggest banks of the land announce the creation of a fund to buy debt securities affected by the recent liquidy drought, the reaction is indifference or even outright hostility.

No wonder. The cartoonishly-named M-LEC (Master Liquidity Enhancement Conduit) will mop up securities, such as bonds backed by toxic mortgages, that would supposedly be dumped at fire sale prices, worsening the damage to balance sheets all over Wall Street.

Now, the banks in question won't put up a cent. M-LEC will sell debt to by debt to fund its purchases, although it seems that the banks will offer some sort of guarantee.

If this sounds fishy, it is. The suspicious securities are in danger of being dumped because their holders can't issue paper to fund their position. But often, it's the banks (or SIVs they sponsor) who are the holders. And if the banks can't or won't step up directly to buy them, why should anyone want to by M-LEC's paper?

Maybe there's some sense to this scheme for the banks. They don't want to buy these iffy securities because they don't want to weaken their capitalization by stretching their balance sheets. So they do a run around by creating an off balance sheet vehicle and pray that they won't have to make good on their guarrantees.

But this sound like a shell game and I simply can't see who would want to fund M-LEC given the reluctance of the banks

The one crucial issue this scheme doesn't address is the lack of transparency and information, which is what arguibly has done the most damage.

So color me skeptical. In the end, there are two possible solutions to this type of mess. One, Uncle Sam steps in by guaranteeing M-LEC's securities. Two, there's a classic reestructuring.